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Notes on Easy Money and Inequality

October 25, 2014 8:38 amOctober 25, 2014 8:38 am

I’ve received some angry mail over this William Cohan piece attacking Janet Yellen for supposedly feeding inequality through quantitative easing; Cohan and my correspondents take this inequality-easy money story as an established fact, and accuse anyone who supports the Fed’s policy while also decrying inequality as a hypocrite if not a lackey of Wall Street.

All this presumes, however, that Cohan knows whereof he speaks. Actually, his biggest complaint about easy money is mostly a red herring, and the overall story about QE and inequality is not at all clear.

Let’s start with the complaint that forms the heart of many attacks on QE: the harm done to people trying to live off the interest income on their savings. There’s no question that such people exist, and that in general low interest rates on deposits hurt people who don’t own other financial assets. But how big a story is it?

The bottom three-quarters of the wealth distribution basically has no investment income. The people in the 75-90 range do have some. But even in 2007, when interest rates were relatively high, it was only 1.9 percent of their total income. By 2010, with rates much lower, this was down to 1.6 percent; maybe it fell a bit more after QE, although QE didn’t have much impact on deposit rates. The point, however, is that the overall impact on the income of middle-income Americans was, necessarily, small; you can’t lose a lot of interest income if there wasn’t much to begin with. If you want to point to individual cases, fine — but the claim that the hit to interest was a major factor depressing incomes at the bottom is just false.

There’s a somewhat different issue involving pensions: as the Bank of England pointed out in a study (pdf) that a lot of Fed-haters have cited but fewer, I suspect, have actually read, easy money has offsetting effects on pension funds: it raise the value of their assets, but reduces the rate of return looking forward. These effects should be roughly a wash if a pension scheme is fully funded, but do hurt if it’s currently underfunded, which many are. So the BoE concludes that easy money has somewhat hurt pensions — but also suggests that the effect is modest.

So where does the impression that QE has involved a massive redistribution to the rich come from? A lot of it, I suspect, comes from the fact that equity prices have surged since 2010 while housing has not — and since middle-class families have a lot of their wealth in houses, this seems highly unequalizing.

Here, however, I think it’s useful to go back to first principles for a second. Do we expect easy money to have differential effects on asset prices? Yes, but mainly having to do with longevity. Values of short-term assets like deposits or, for that matter, software that will soon be obsolete don’t vary much with interest rates; values of long-term assets like housing should vary a lot. Equities are claims on the assets of corporations, which include a mix of short-term stuff like software, long-term stuff like structures, and invisible assets like goodwill and market position that may span the whole range of longevity.

The point is that it’s not at all obvious why housing should be left behind in general by easy money. In fact, one of the dirty little secrets of monetary policy is that it normally works through housing, with little direct impact on business investment.

So why was this time different? Surely the answer is that housing had an immense bubble in the mid-2000s, so that it wasn’t going to come roaring back. Meanwhile, stocks took a huge beating in 2008-9, but this was financial disruption and panic, and they would probably have made a strong comeback even without QE.

If we take a longer-term perspective, you can see that the relationship between monetary policy and stocks versus housing varies a lot. The charts show real stock prices (from Robert Shiller) and real housing prices:

Photo

Credit Robert Shiller

Photo

Credit

The easy-money policies that followed the bursting of the 90s stock bubble produced a surge in housing prices, not so much in stocks — the opposite of recent years. The point is that a lot depends on the history, and the belief that QE systematically favors the kinds of assets the wealthy own is wrong or at least overstated.

Meanwhile, for most people neither interest rates nor asset prices are key to financial health — instead, it’s all about wages. And new research just posted on Vox, using time-series methods on micro data, finds that

the empirical evidence points toward monetary policy actions affecting inequality in the direction opposite to the one suggested by Ron Paul and the Austrian economists.

Which brings me back to the reason most of us favor QE. No, Janet Yellen and I aren’t secretly on the Goldman Sachs payroll. Nor do I (or, I suspect, Yellen) believe that unconventional monetary policy can produce miracles. The main response to a depressed economy should have been fiscal; the case for a large infrastructure program remains overwhelming.

But given the political realities, that’s not going to happen. The Fed is the only game in town. And you really don’t want to trash the Fed’s efforts without seriously doing your homework.